What Partners and Shareholders Should Know about Personal Exposure When Putting Their Business in Chapter 11

In many small and medium-sized businesses, one or more of the partners or shareholders—also called equity security or equity interest holders—manage the day-to-day operations of the business. In this capacity, the partner is an acting principal of the business and, as such, often incurs personal liability for some—but rarely all—of the business debts by way of personally guaranteed security and loan agreements, personally guaranteed SBA notes or co-signed leases. A partner can also be held personally liable for some business debts usually owing to government and taxing authorities by way of statute, for example personal assessment for business taxes and even employee wages in some instances.

When a business files chapter 11, the question naturally arises what happens to the partner’s liability for business debts and what exposure does the partner face when his/her business files chapter 11. This articles attempts to address some of those concerns in the context of a privately held (i.e., not publicly traded) small or medium-sized business that files a chapter 11 reorganization proceeding. The term ‘partner’ is used interchangeably in this article with the concepts of equity ownership, whether that persona be a partner, principal or shareholder of the business depending on how it was formed or organized.

The Automatic Stay Protects the Business from Collection but Not Necessarily a Partner-Guarantor

Most people know that filing a bankruptcy proceeding invokes the sweeping protections of the “automatic stay”, which stays (i.e., legally stops) further collection efforts and pending lawsuits from proceeding. The automatic stay is one of the core principles of bankruptcy relief, as it affords the necessary time and relief from levies, repossession, evictions, expensive and burdensome lawsuits and other collection efforts in order for the business to come forward with a plan of reorganization. The automatic stay remains in place for the duration of any bankruptcy proceeding until such time the case is either dismissed or the plan of reorganization is confirmed or until the time that a party in interest, usually a creditor or landlord, successfully ‘lifts’ the automatic stay for cause granted by an order of the bankruptcy court. The grounds for relief from the automatic stay are not addressed in this article.

From a partner’s perspective, it is important to understand that there is no co-debtor automatic stay in chapter 11 proceedings. This means, for example, that a pre-bankruptcy lawsuit pending against both a business and its partner as co-defendants will be automatically stayed once the business files chapter 11. However the plaintiffs may still proceed against just the partner if they dismiss the lawsuit as to the business. Also this means that a partner can still be personally collected upon for existing judgments and still be personally assessed for business taxes in spite of the business bankruptcy proceeding. While personal collection efforts are often voluntarily put on hold by creditors when the business files chapter 11, the automatic stay nevertheless only applies to the business. For this reason, partners with significant personal guarantees may themselves need to file an individual bankruptcy proceeding.

The Chapter 11 Attorney Represents the Business, Not the Partners

It is a conflict of interest for the business chapter 11 attorney to render legal advice or formally represent the partners or equity security holders while representing the business. This can seem like an inconsistency when the partner maintains a primary, close and constant relationship with the business counsel. While it can be difficult for a partner of a closely held company to distinguish between the interests of the company and their own personal interests, occasionally events occur that could give rise to a conflict between what is best for the company and what is best for the partner. In all instances, however, the partner has a fiduciary duty to act in the best interests of the company and not himself, and the chapter 11 likewise has an obligation to represent the interests of the business alone. Due to this conflict of interest, partners may wish to consult with independent counsel on how their rights may be impacted by the business chapter 11 proceeding.

Personal Guarantees and Liabilities are Rarely Extinguished by the Chapter 11 Plan

The majority of chapter 11 plans do not allow for third-party releases or injunctions to protect guarantors, insiders and other non-debtor parties from lawsuits, collection efforts or otherwise. While there are exceptions to this general rule, partners and guarantors will need to find a resolution outside of the business chapter 11 proceeding.

Partners May Need to Contribute New Capital to the Plan Funding

Also called the Absolute Priority Rule, the general idea is that if creditors are going to take a financial hit, so should the partners.  The rule of thumb is that unless the plan proposes to repay all creditors in full, the partners must contribute new value in a reasonably equivalent amount to the value of the ownership interests retained. There are deviations on this rule, including that a partner may contribute new capital, cash or letters of credit to the business. The rule is not always enforced and

Other Risks: Preference Payments to Partners and Other Avoidance Actions

 Article V avoidance actions are fairly common in all chapters of bankruptcy, and particularly so in chapter 11 proceedings. Both partners and creditors alike can be subject to actions to avoid transfers of funds or assets so that those funds can be recovered for the benefit of the bankruptcy estate and unsecured creditors. While a reasonable salary paid to a partner for managing the business won’t necessarily be avoided, partner distributions and withdrawals made while the business was insolvent may be subject to avoidance. The general look back for avoidance actions is 90 days for non-insider creditors/other parties and up to one year for insiders such as partners, related companies and others having a close relationship with the debtor business. There are specific rules and limitations as well as affirmative defenses for preferences actions and transactions need to be evaluated on a case by case basis. Future compensation and salary to be paid to partners must also be disclosed in the chapter 11 plan and will need to reasonable and necessary or otherwise the plan could draw an objection.

Pros and Cons of Small Business Chapter 7 Bankruptcy

It happens to many small businesses: Operations and sales start slumping. While a few creditors offer forbearance of payments of even short-term extensions of credit, it’s just not enough. Perhaps the business grew too quickly for the principals to manage operational demands under an increased debt load. Perhaps the business model wrongly assumes receivables will be timely paid to keep the cash flowing as needed for debt service. Or the taxing authority has come knocking for prior unpaid withholding or sales taxes. Or a lawsuit naming the business as defendant has forced the principals to confront the business’s future viability considering the costs of litigation defense, the possibility of a significant monetary judgment or repossession of critical equipment.

There are many precursors to business insolvency, with some factors beyond the control of even the most assiduous of small business owners. It’s always a difficult decision for an owner who has invested their time and personal savings into a business to wind-down operations and mitigate the consequences of unpaid debts.

Unfortunately, the closing of a small business often means the owner should file a personal bankruptcy proceeding to discharge their personal guarantees. But should the business also file a chapter 7 bankruptcy? The answer may be surprising.

Pros of Small Business Chapter 7 Bankruptcy:

  • Orderly liquidation of business assets. A trustee is assigned to liquidate the remaining assets of the business and use the net proceeds after the trustee takes their cut to pay down the liabilities in order of priority. This process is especially useful if the business’s principals are unable to liquidate the business assets and there is significant inventory to be dealt with.
  • A trustee takes over all existing operations. A trustee will immediately be assigned to manage and control the remaining operations of the business, taking the burden off the business principals and owners to terminate employees and leases, surrender collateral to secured creditors, manage bank accounts, etc. This can also be viewed as a negative consequence by some small business owners (see below).

Cons of Small Business Chapter 7 Bankruptcy:

  • A trustee takes over all aspects of the business. A trustee will take over management and control of the business and the principals will be sidelined to simply watch and see what happens. This can be beneficial if the business is still operational and the principals no longer wish to manage the business through its winding-down, or can be viewed as a negative if the principals still have an interest in operating the business for some longer period of time and do not wish to see the business ‘go dark’ under the management of a bankruptcy trustee.
  • No discharge of debts. Unlike a personal chapter 7 bankruptcy, there is no discharge of debts at the end of a business chapter 7 proceeding. At the end of chapter 7, the business will simply be defunct, dead in the water and typically still owing liabilities.
  • Assets will be liquidated. Since a trustee will be liquidating the business assets, those assets are likely to be sold as quickly and cheaply as possible. This could mean a loss of equity in the assets. A fire sale by the trustee may also mean that personally guaranteed debts may not be minimized if assets are sold for less than the owner could potentially sell for herself/himself to pay down the debts.
  • Attorney and filing fees for chapter 7 can run into the thousands of dollars.
  • Personal exposure and risk to the business principals/owners. There is always a chance that a business chapter 7 filing will result in exposure to avoidance actions brought by the trustee against the owners and/or principals of the business. One common example is when the trustee sues a principal to recover for the benefit of the business creditors any distributions or draws taken by that principal in the one year prior to filing. For this reason, it is imperative that the business hire an experienced business bankruptcy attorney who can evaluate the risk and exposure faced by the principals/owners if the business files chapter 7 and their possible defenses. Note that if a principal is sued by the trustee, the principal must hire separate counsel since the business bankruptcy attorney cannot represent both the business and its principals.

There are other, non-bankruptcy issues surrounding the winding down of failed business enterprise which may require the services of a business attorney. Even if chapter 7 does not make sense for the business—as often it does not make sense especially for smaller businesses—the small business owner may still wish to be advised on how to resolve personally guaranteed debts, personally assessed taxes unpaid by the business, as well as how to navigate and avoid potential issues of alter ego should the owner wish to form a new business entity that is free and clear of any of the failed business’s debts.

For the small business owner that contacts my firm for assistance, I suggest the following steps:

  • The business owner should evaluate what business debts are personally guaranteed and/or may be personally assessed. Personally owed debts may include business credit cards, leases and personally guaranteed SBA loans as well as unpaid business taxes. The answer to this may lead the owner to seek out personal bankruptcy representation.
  • Should the owners attempt to wind down the business themselves, with or without the assistance of an attorney, or does chapter 7 bankruptcy offer any significant benefits in spite of the fact that there is no discharge of debts.
  • Have an attorney evaluate the exposure and risk to the business owner, either in the event that a business bankruptcy is filed or under certain circumstances, for example the owner took possession and control of business assets and funds to the detriment of its creditors.

Can a Divorcing Couple File a Joint Bankruptcy? And when it’s just not a good idea.

Divorcing couples can file a joint bankruptcy proceeding so long as they are still married on the date the bankruptcy petition is filed and, most importantly, when they agree to be completely cooperative and open about their finances with each other. The bankruptcy proceeding will not stay (i.e., delay) the divorce proceeding in most instances, so that both proceedings can happen simultaneously.

The benefit to a joint bankruptcy proceeding is the cost savings of one case instead of two but the couple must remain transparent for the duration of the proceeding including about their income and employment, finances and expenses, current living situation including any financial contributions and expenses of a new significant other, etc. There can be no secrets or confidences between the attorney and one of the two spouses that are jointly represented.  Even the most cordial of divorcing couples can turn sour when a disagreement arises in the divorce especially when it comes to the hot topics of spousal support, custody and division of assets.

Married couples can also file separate bankruptcy cases, and it is common for one spouse to file bankruptcy while the other spouse does not.

The ideal situation for a jointly administered bankruptcy case is when the divorcing couple is eligible to file a joint chapter 7 proceeding, which typically lasts three months start to finish. If the divorcing couple is not eligible for chapter 7, they can still file a joint chapter 13 however this is often can be impractical since most chapter 13 plans last five years.

There are also situations where one spouse (or both) may benefit from divorcing first, especially in a situation where one spouse does not qualify for chapter 7 without a support obligation in place. It becomes difficult and potentially a conflict of interest for the attorney when the best interests of one spouse conflicts with the other’s best bankruptcy plan. When any conflict happens, one spouse needs to seek separate counsel to file a separate bankruptcy case. If there’s any foreseeable conflict, it may be better to pursue separate bankruptcy proceedings from the start.

Generally to be eligible for chapter 7, the combined annual gross income must be no more than the applicable state median income for their household size. Under the “means test” calculation, it may still be possible for otherwise above-median debtors to qualify for chapter 7 when the divorcing couple maintains two separate households and when there are certain expenses and/or debts owed, including above-average health care costs, domestic support obligations, mortgage arrears owed, significant state or federal taxes are owed, and when there are mortgage or other secured debt payments that will be maintained. Sometimes eligibility for chapter 7 becomes possible after divorce, especially if the couple is still residing together now and one or both spouses only qualifies for chapter 7 once they have a smaller, separate household for the purposes of the means test.

Also see Bankruptcy and Divorce: What Should Come First

Why am I having a hard time refinancing after bankruptcy?

You filed a bankruptcy case to resolve your debts. So why aren’t you qualifying for a refinance on your home mortgage? The title company may be able to shed some light on specific problems but the common culprit may be misperceptions about bankruptcy.

It could be your credit score.

Most underwriting guidelines for new FHA mortgages and FHA home refinances require a minimum credit score of 640 and also waiting at least two years since the discharge order was entered in your chapter 7 case. If you filed a chapter 13, the guidelines require the 640+ credit score and also waiting a minimum of one year since the chapter 13 plan was confirmed with verification from the chapter 13 trustee that all plan payments have been timely made and other obligations have been fulfilled. Typically a credit score improves after bankruptcy since debts are then discharged and no longer reporting as in default. However it takes proactive work and time to improve a credit score, including maintaining current payments on mortgages, reaffirmed auto loans and student loans that survive the bankruptcy case. Pull your credit report at www.annualcreditreport.com (note this site will not give you your credit score). Review the report for negative items. Challenge any inconsistencies or incorrect reporting information. Work to improve your credit by obtaining new credit.

Chapter 13 might be the problem.

If you filed chapter 13 case, it’s critical to understand that debts are not discharged until the plan is complete. Many people have the misperception that debts are discharged upon the chapter 13 plan being confirmed. However debts are not discharged until every obligation under chapter 13 plan is complete including all 3 to 5 years of payments being made. The reason for this is because if your chapter 13 case is dismissed before it is completed, those debts are resurrected subject only to any distributions that have been made by the chapter 13 trustee which reduce the balance owed. So if you are currently in a chapter 13 plan, your debts are still legally operative and owed by you until a discharge is received at the end of the plan. Additionally in chapter 13, the case is typically not closed until five months after you receive a discharge. This means that a chapter 13 case is technically open and active for up to 5 1/2 years, all the while impeding your credit score and your chances for qualifying for a refinance or new mortgage during that time. If you are still in an active chapter 13 plan, some lenders will require the chapter 13 trustee’s approval of the loan.

It could be the judgments obtained against you prior to filing bankruptcy.

While most judgment debts are discharged in bankruptcy (judgments for criminal restitution, child support and other domestic support, or even fraud are often not discharged), the state court system is not updated automatically with your bankruptcy information. In Minnesota, there is a secondary and optional process after you receive a discharge for having the state court docket updated to reflect the pre-bankruptcy judgments were discharged in bankruptcy. This process is called application for discharge of judgment and while it does not require the assistance of attorney, it is fairly affordable and certainly more convenient to have an attorney do this for you. Once the state court docket is updated with the bankruptcy discharge information, these judgments will reflect as discharged on your credit report. If you do not complete this process, the underlying debts are still uncollectible by law however the judgments are still shown as active on the state court docket and thus possibly also on your credit report.


When in doubt, look into your mortgage modification options.

As an alternative to a traditional refinance, consider applying under one of the federal mortgage modification programs. Low credit scores, judgments and even a bankruptcy are less likely to impact your eligibility for a mortgage modification than in qualifying for a refinance. As an additional benefit, the interest rates available through modification programs are often lower than what a poor credit score can achieve in the open market. There is also the added bonus of no refinance fees, since participating in a federal program involves no closing costs either out of pocket or added to your mortgage balance. The federal website that provides a comprehensive listing of all programs is available at www.makinghomeaffordable.gov.

See also Qualifying for a Mortgage After (or During) Bankruptcy: What does it take and how long will I wait?

Qualifying for a Mortgage After (or During) Bankruptcy: What does it take and how long will I wait?

It should come as no surprise that qualifying for a new mortgage or refinance with a bankruptcy in your credit history is likely to complicate the process. But while a bankruptcy will stay on your credit report for a full ten years after your case is complete—which means up to fifteen years total for individuals who file chapter 13—bankruptcy takes its biggest bite on creditworthiness in the first two to three years after the case is first filed.

The good news is that bankruptcy does not automatically disqualify a borrower from obtaining a new mortgage or refinance, and the most available product after bankruptcy usually will be a FHA mortgage (as opposed to a conventional mortgage). The bad news is that eligibility for a mortgage will take time, usually two years or more with reestablished good credit.

As a general rule of thumb, a debtor can qualify for a FHA mortgage or refinance either during or after bankruptcy under the following guidelines:

Chapter 7 or Chapter 11 Bankruptcy: At least 2 years have elapsed since the date of discharge of debts and the borrower has a credit score at least a 640. In most chapter 7 cases, the discharge of debts is entered three months after the case is initially filed.

Chapter 13 Bankruptcy: At least 1 year has elapsed since the filing chapter 13 bankruptcy and the borrower has a credit score at least 640, plus the borrower can provide lender with a verified perfect payment history of their chapter 13 plan. Some lenders may also require the chapter 13 trustee’s approval of the loan.

Note: For conventional mortgage products and rural housing, the typical waiting period may be extended to three years or more and often with higher credit score requirements.

If you filed a chapter 7 or chapter 13 bankruptcy, or you are still in an active chapter 13 plan, work now to increase your odds to qualify for a mortgage product by doing the following:

  • Reestablish a good credit score now. The better the credit score, the lower the interest rate will be. While it won’t happen quickly, you do not have to wait until bankruptcy is complete to work on improving a credit score. Pay your mortgage, student loans, vehicle leases and auto loans on time each month so that you get the benefit of the positive credit reporting. If your student loan is in default, get it back on track with an Income Based Repayment program. Don’t let new debts and bills fall into collection. Check your credit report annually for errors that negatively impact your score. And consider a secured credit card or even a traditional credit card with a low limit—use it sparingly, keep the balance below 10% of the available credit limit or, better yet, pay it off in full each month. If your bankruptcy case is already complete, have the state court docket updated to show any pre-bankruptcy judgments were discharged in your bankruptcy case.
  • If you are in an active chapter 13 plan, ensure your monthly chapter 13 plan payment is made on time each month. For debtors with cash flow problems, this may mean that you set up your monthly plan payments to be automatically deducted from your wages or otherwise have your plan payment made via ACH deduction from a bank account.
  • Be prepared and be patient. At a minimum, most borrowers will have to wait at least two years from when a bankruptcy was filed before they will qualify for a FHA mortgage.

As an alternative for homeowners looking to refinance an existing mortgage who do not meet the underwriting requirements for a traditional refinance, the Making Home Affordable program administered through the federal government may offer a better solution. Obtaining a HAMP or HARP mortgage modification essentially provides the benefit of a cost-free refinance with market interest rates however without the strict credit score/financial history requirements or mandatory post-bankruptcy waiting periods. These programs will not exist indefinitely and as of the date of this post, Congress has approved the Making Home Affordable program only through the end of 2016. To identify the various programs and requirements for a mortgage modification, see the official HUD website on Making Home Affordable.

DISCLOSURE: This information is intended as a general guideline only and is not meant to be a definitive response on any individual qualification for a mortgage or refinance. Mortgage underwriting standards change frequently and only a banking institution or loan officer can determine eligibility for mortgage products.

The 2017 Chapter 13 Debt Limits (valid through 2019)

Effective April 1, 2016 and valid for all of 2017 and 2018, the debt limits for filing chapter 13 bankruptcy as prescribed by section 109(e) of the Bankruptcy Code are as follows:

Unsecured debt limit:            $394,725

Secured debt limit:                $1,184,200

These limits adjust every three years and the next chapter 13 debt limit adjustment will occur on April 1, 2019.

The secured debt limit of $1,184,200 includes the total of all debt that is secured by personal and real property owned by the debtor including mortgages secured by real estate (i.e., residential homestead mortgages as well as mortgages on rental or commercial properties, if any) and other collateralized debts such as vehicle loans, equipment loans, etc. The secured limit may also include tax liens.

The unsecured debt limit of $394,725 includes the total of all amounts owed on unsecured lines of credit, credit cards, medial debts and other consumer debts, some taxes owed and even disputed debts in most cases. This unsecured debt limit is calculated per person in the event that a married couple files a joint chapter 13 bankruptcy case.

Any individual that is either employed or self-employed in business is eligible for chapter 13 bankruptcy relief provided the individual’s unsecured debts are within these limits of $394,725 unsecured / $1,184,200 secured.

Individuals who exceed the chapter 13 debt limits still have the option to file under chapter 7 so long as their income qualifies under the means test, or otherwise may file an individual Chapter 11 proceeding, particularly for individuals with income-producing assets such as rental properties, valuable business interests and other property holdings that would be liquidated in chapter 7.

If you exceed the 2016 chapter 13 debt limits, read more about alternatively filing under chapter 11 at What is Individual Chapter 11 Bankruptcy and Why Would I file an Individual Chapter 11?

Attorney Lynn Wartchow advises clients on which form of bankruptcy they qualify for and whether Chapter 7 or Chapter 13 fits their needs best.  Contact for a free consultation and more information on all your options available in bankruptcy.

2016 Minnesota Median Income effective for bankruptcy cases commenced on April 1, 2016 or later (estimated to be good through at least November 2016)

Median income is a critical measure in bankruptcy upon which the ‘Means Test’ calculation is largely based to determine whether a debtor qualifies for Chapter 7 bankruptcy versus Chapter 13. Essentially, if a debtor’s annualized gross income exceeds the median income for their household size and state of residence, they are generally (but not always) ineligible for Chapter 7 bankruptcy and instead steered toward a five-year Chapter 13 repayment plan.  In Chapter 13, median income also determines whether a debtor is required to do a 5-year plan (when above-median income) or 3-year plan (when below-median income).

It’s also important to note that annualized gross household income is determined by doubling all household income from all sources for the last six full calendar months prior to filing bankruptcy. Chapter 13 bankruptcy is a more likely outcome than Chapter 7when this annualized income is above the applicable state median income. The Means Test calculation and eligibility for Chapter 7 is more complicated than simply a measure against median income and other factors including mortgage payment as well as arrears, taxes owed and domestic support obligations, and a number of other factors also figure into the means test calculation.

As of April 1, 2016, the Median Income in Minnesota is as follows:

2016 Minnesota Median Income per applicable Household Size:         

1 Person          2 People          3 People          4 People          5 People

$51,260           $68,596           $80,900           $98,564           $106,964 

State median income is determined by Census Bureau data and adjusts at least annually. The latest adjustment is effective April 1, 2016 and the next adjustment date is expected November 2016.

To read more about Median Income and the Means Test, see What is the Median Income in Minnesota and How Does is Factor into Chapter 7 Bankruptcy and What is the “Means Test” and Why Does it Matter in Bankruptcy?

Wartchow Law Office is a law firm located in Edina, Minnesota with an exclusive practice in Chapter 7, Chapter 13 and Chapter 11 bankruptcy law, representing individual consumer and business clients throughout the Twin Cities of Minneapolis and St. Paul, Minnesota.

2015 Minnesota Median Income effective for bankruptcy cases commenced on/after November 1, 2015 and through April 2016

Median income is a critical measure in bankruptcy upon which the ‘Means Test’ calculation is largely based to determine whether a debtor qualifies for Chapter 7 bankruptcy versus Chapter 13. Essentially, if a debtor’s annualized gross income exceeds the median income for their household size and state of residence, they are generally (but not always) ineligible for Chapter 7 bankruptcy and instead steered toward a five-year Chapter 13 repayment plan.  In Chapter 13, median income also determines whether a debtor is required to do a 5-year plan (when above-median income) or 3-year plan (when below-median income).

It’s also important to note that annualized gross household income is determined by doubling all household income from all sources for the last six full calendar months prior to filing bankruptcy. Chapter 13 bankruptcy is a more likely outcome than Chapter 7 when this annualized income is above the applicable state median income. The Means Test calculation and eligibility for Chapter 7 is more complicated than simply a measure against median income and other factors including mortgage payment as well as arrears, taxes owed and domestic support obligations, and a number of other factors also figure into the means test calculation.

As of November 1, 2015, the Median Income in Minnesota is as follows:

2015 and 2016 (through 04/01/16) Minnesota Median Income per applicable Household Size:         

1 Person          2 People          3 People          4 People          5 People

$51,199           $68,515           $80,804           $98,447           $106,547 

State median income is determined by Census Bureau data and adjusts at least annually. The latest adjustment is effective November 1, 2015 and the next adjustment date is expected April 2016.

To read more about Median Income and the Means Test, see What is the Median Income in Minnesota and How Does is Factor into Chapter 7 Bankruptcy and What is the “Means Test” and Why Does it Matter in Bankruptcy.

Wartchow Law Office is a law firm located in Edina, Minnesota with an exclusive practice in Chapter 7, Chapter 13 and Chapter 11 bankruptcy law, representing individual consumer and business clients throughout the Twin Cities of Minneapolis and St. Paul, Minnesota.

 

Minnesota Bankruptcy Courts Now Allow a Chapter 13 Debtor to Compel a Mortgagee Bank to either Foreclose or Take Deed to a ‘Zombie Property’

On September 1, 2015, the honorable Judge Michael Ridgway of the US Bankruptcy Court for the District of Minnesota joined several other jurisdictions nationally in recognizing a chapter 13 debtor’s ability to compel her mortgage bank to either foreclose a property or to take deed to a property for which it had previously refused to foreclose. In so creating this new caselaw in Minnesota, Judge Ridgway has now established the legal procedure for debtors to get out from under a ‘zombie property’, i.e.., a property that the bank refuses to foreclose for financial reasons unknown.

Particularly when it comes to zombie condos and townhomes, mortgagee banks often elect not to foreclose in effort to avoid incurring the homeowner’s association fees, real estate taxes and other accruing costs for a property that may not easily sell to recoup its losses. For such zombie properties, the homes can remain abandoned for years before it is finally either subject to a tax forfeiture proceeding or the toxic mortgage is eventually assigned to a bank who will foreclose. To the homeowner, however, it means years of uncertainty and increasing personal liability for homeowner’s association assessments and other costs of remaining the titled owner to an unwanted home.

For now in Minnesota, chapter 13 bankruptcy offers an avenue of relief in that the debtor can now force a lienholder—i.e., the mortgage bank, the homeowner’s association, or perhaps even the county itself—to either foreclose the property or take deed to the property.

In In re Stewart (Case No 15-40709-MER), the chapter 13 debtor had long-abandoned a condominium property in her former state of residence, Maryland, before moving to Minnesota and eventually filing for bankruptcy relief. For over three years, the condo sat vacant, abandoned and awaiting foreclosure by the bank or any other lienholder for that matter. Yet despite her many efforts to cooperate in a voluntary foreclosure or even deed-in-lieu the property to its lienholders, no one wanted to take deed and ownership to the zombie condo. Even after successful completion of a 5-year chapter 13 plan, she would have emerged from bankruptcy owing tens of thousands of dollars in HOAs and other costs if property continued to not be foreclosed. In essence, the very purpose of her bankruptcy proceeding would have been negated if she could not rid herself of the debts associated with the condo. Therefore, her chapter 13 plan—which was confirmed without objection by any party—provided that the condo unit would vest in its mortgagee bank (One West Bank at that time) in satisfaction of the claim and the deed would so transfer out of her name at long last. Yet over two years after her chapter 13 plan was confirmed, neither the mortgagee bank nor the homeowner’s association made any attempts to foreclose the zombie property. So the debtor and her attorney, Lynn Wartchow, brought a motion to compel the mortgagee bank to either foreclose or take deed to the property once and for all.

In so deciding in favor of the debtor and enforcing the terms of her chapter 13 “Baxter Plan”, Minnesota is now aligned with several other bankruptcy courts including Hawaii (In re Rosa, 495 B.R. 522 (Bankr. D. Haw. 2013)), Oregon (In re Watt, 520 B.R. 834, 839 (Bankr. D. Or. 2014)), Massachusetts (In re Sagendorph, II, 2015 WL 3867955 (Bankr. D. Mass. June 22, 2015)) and the Eastern District of New York (In re Zair, 2015 WL 4776250 (Bankr. E.D.N.Y. Aug. 13, 2015)).

The full memorandum opinion and order of In re Stewart may be viewed on the bankruptcy court’s website at http://www.mnb.uscourts.gov/sites/mnb/files/opinions/Stewart%2013-40709%20Opinion.pdf.

 

Debt Consolidation vs. Debt Settlement vs. Bankruptcy? What Can You Expect from Each and Which Option is Better?

When facing mounting debts that cannot be repaid according to the regular monthly terms, one should consider all options for debt resolution including bankruptcy relief and non-bankruptcy alternatives. But before you hastily take the most convenient option, consider the benefits and disadvantages for each. In fact, I often encourage my bankruptcy clients to make an apples-to-apples comparison between their debt resolution options—including a list of the pros, cons, risks and costs for each resolution—and often the best and cheapest option quickly becomes clear.

Debt consolidation is a general term for taking out one larger, lower interest loan and using the loan proceeds to pay off any number of smaller, higher interest rate debts. In this way, you are repaying 100% of your debts but potentially saving money on interest over time. While balance transfers and credit card checks with promotional interest rates may be tempting, it’s critical to read the fine print for any hidden fees of balance transfers and the deadlines when the promotional interest rates expire. For example, credit cards and some new loans will charge a small percentage fee on the amount of credit used for the balance transfer or to initiate the loan. Also, the promotional rate expires in only a short time and often any balance remaining after that deadline will revert to the standard interest rate which can be three times higher than the promotional rate. Debt consolidation may work best for people who have regular, predictable income so that they can commit to the monthly consolidated payment and their only issue is the high interest rates. Debt consolidation also assumes that you can obtain financing at a lower interest rate than your current credit cards, which usually necessitates a minimum credit score if not also a pledge of collateral to secure the consolidation loan. Debt consolidation usually will not work well for people who cannot afford a consolidated loan payment (even at lower interest) or for those who cannot obtain new credit due to a low credit score and/or lack of collateral.

Debt settlement (or debt negotiation) is an option that occasionally makes more sense than filing bankruptcy, particularly for higher income individuals, individuals with substantial assets or individuals with access to cash to pay off just a few debts at a reduced balance. Debt settlement involves negotiating a final settlement of the debt and release from future personal liability one-by-one with each creditor. Depending on the number of debts that need to be settled and how far into default each debt is, the debt settlement process can be tedious, expensive and can easily take two or more years to complete with all creditors. There is always the risk that until the debt is fully settled, the creditor can still collect on the full balance and initiate a lawsuit against you. Depending on individual circumstances, debts will typically settle for 25% to 75% of the amount owed and payment is required in either one lump sum or series of payments over no more than six months. Because inevitably some of the debt is repaid and you may end up incurring attorney fees for assistance with the process, debt settlement is almost always more costly overall than a standard chapter 7 bankruptcy proceeding. Finally and unlike what happens when a debt is discharged in bankruptcy, beware that a debt settled for less than the full amount owed often will result in your receiving a Form 1099 for the amount forgiven which is treated as income for tax purposes (with few exceptions, see Received a 1099-Misc on Cancelled Debt? You May Qualify for Exclusion from Taxes if You Were Insolvent or Filed Bankruptcy). For these reasons, debt settlement can be a far more expensive and time-consuming option than bankruptcy.

In bankruptcy, most unsecured debts are discharged in full and the majority of chapter 7 debtors pay nothing more than the attorney fee and filing fee. In chapter 13, some percentage of the debts is repaid but the total paid into a chapter 13 plan can still be significantly less than what a debt settlement may cost.

For help in assessing of your debt resolution options, contact Wartchow Law Office located in Edina, Minnesota.